Components of the US Economy, Part 2

The US Economy - What Traders Need to Know Part 2

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In our last lesson we began a discussion on the different components that make up the US Economy and how these relate to trading with a look at the Natural Resources and Labor Force components. In today’s lesson we continue this discussion with a look at the Private Sector and Government components and how each of these relates to trading.

While having lots of natural resources and a large well educated labor force to produce goods and services from those natural resources is a great thing, without a way to organize these first two components of the economy, not much would get done. This is where the small, medium, and large businesses which make up the private sector come in. In addition to organizing the labor force to produce goods and services, the private sector is also responsible for raising the capital necessary to bring all these things together which they do through private investors, loans from commercial banks, the bond market, and/or the equities market.

While many people think that the US Economy is dominated by the large corporations, it may come as a surprise the large role that the small business play’s in the US Economy. According to the US Department of State:

"Of the nearly 26 million firms in the United States, most are very small—97.5 percent ... have fewer than 20 employees," the U.S. Small Business Administration says. "Yet cumulatively, these firms account for half of our nonfarm real gross domestic product, and they have generated 60 to 80 percent of the net new jobs over the past decade."

While we will go into more details about the private sector and how this all relates to trading in later lessons, it should be obvious at this point the large effect that the private sector has on all markets as they are the ones who: 1. Raise capital through bonds and stocks that we then trade, 2. produce the goods and services which drive demand for the commodities we trade and 3. Affect the foreign Exchange markets by playing a role in what goods and services are produced domestically, which we import from overseas, as well as cross boarder mergers and acquisitions.

The fourth component that I am going to discuss here is the role that government plays in the US Economy. There are several important roles that the government plays in the economy which can drastically affect the markets one of the more prominent of which is that of Regulator. There are many parts of the US Economy that the government regulates with some of the more prominent areas being:

Anti Trust Laws: These laws are in place to protect the consumer from businesses that grow so large that there are no other businesses that can compete with them, basically allowing those businesses to set unfair prices due to the lack of free market competition.

Environmental Laws: These laws are in place to protect the environment by establishing maximum levels of pollution that businesses are allowed to produce and then checking to make sure that these levels are not breached through agencies such as the Environmental Protection Agency.

Securities Regulators: The government is in charge of monitoring and regulating many parts of the financial system through agencies such as the Securities Exchange Commission and the Commodities Futures Trading Commission.

The primary way in which the role that government plays in the regulation of the economy affects us as traders is through how increases in regulation and decreases in regulation are taken by the market. In general anything that makes it easier to do business which normally means less regulation is going to be seen as positive for the market and anything that makes it harder to do business which is normally associated with more regulation is going to be seen as negative for the economy.

That’s our lesson for today. In tomorrow’s lesson we are going to continue our discussion on the role that government plays in the economy and how this relates to trading with a discussion on Fiscal Policy or how government spending and taxes affect the markets so I hope to see you in that lesson.

As always if you have any questions or comments please leave them in the comments section below so we can all learn to trade together, and good luck with your trading!


External Links:

Good overview of the US Economy

Understanding the Economy from CNN Money

Guide to the US Economy

Components of the US Economy, Part 1

The US Economy - What Traders Need to Know Part 1

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In our last lesson we gave an introduction to fundamental analysis with an introduction to the top down approach to analyzing fundamentals and the US Economy. In today’s lesson we are going to expand our discussion on the US economy by looking at the different pieces which make up the economy and how each piece is relevant to us as traders of the stock, futures, and/or forex markets.

The first component of any economy is its natural resources. One of the key factors that allowed the United States to grow so quickly and become one of the world powers that it is today, is that it is a land that is rich in natural resources from oil which drives our industry, to lumber to build our houses, to our large coastlines, great lakes, and rivers which provide shipping access and move goods throughout the country.

Understanding what natural resources are most important to a country and understanding what affects the prices of those resources is beneficial to not only commodities traders who trade the actual commodities such as oil and gold but also to traders of the stock and forex markets. We will go into these correlations in more detail in later lessons but a short example is that the US economy relies heavily on oil, so when the price of oil goes higher this is normally seen as a negative for the US Economy as it then costs more for companies to ship their goods, and for individuals to fill up their cars leaving them less money to spend. Similarly, as the US Imports much of its oil, when the price of oil goes up this means that more dollars are being sold and converted into the currencies of the countries which are exporting the oil to the US, therefore all else being equal weakening the US Dollar and strengthening the currency of the exporting country.

The next component of any economy is its labor force, or the individuals who are working in that economy to produce goods and services from the countries natural resources. As the labor force in an economy gets paid for their labor, and then spends that money on the goods and services they and other components of the labor force have produced, they are an important driver of growth in any economy.

The components which are watched in regards to labor are the size of the labor force in an economy, its rate of growth, its productivity level, and its skill level, and its mobility or ability to adapt to changing conditions. Another reason why the United States has the largest economy in the world is the size of its labor force is constantly growing allowing the economy to produce and sell more goods and services, it is a relatively mobile labor force which has allowed it to increase productivity faster than other nations through things such as early adoption of new technology, and it is an educated labor force.

Why is this important from a trading standpoint? Here again we will go into more detail on this when we look at important economic numbers but a short example is if the labor force becomes more productive, this means that they are able to produce more goods in the same amount of time. This not only makes companies more profitable but it holds down prices for the consumer, giving them more money to spend on other goods and services, which drives growth, which means a higher stock market all else being equal. This increased growth can cause higher demand for commodities therefore causing the commodities markets to rally all else being equal, and can also have interest rate implications, something we will learn about in later lessons, which can affect the US Dollar.

That’s our lesson for today. You should now have a good understanding of the first two components of the US economy its natural resources and labor force. I hope you are also beginning to see how the fundamentals are intertwined into all markets, so at least having a basic understanding of them is important regardless of whether you are basing your trading decisions on them or not. In tomorrow’s lesson we are going to look at the second two pieces of an economy: the Private Enterprise and the Government and the role that each of these play so we hope to see you in that lesson.

As always if you have any questions or comments please leave them in the comments section below so we can all, learn to trade together, and have a great day!

External Resources:

CIA World Factbook US Page

USINFO Government Economic Overview

BEA Overview of the US Economy

Intro to Fundamentals and the US Economy

An Introduction to Fundamental Analysis and the US Economy

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Next Lesson

In our last lesson we finished up our series on money management with a look at another way that traders determine their position sizing, the % Volatility Method. In today's lesson we are going to start a new series on Fundamental Analysis.

As I discussed in my very first lesson, there are two ways that traders analyze the markets which are known as technical analysis and fundamental analysis. As I also mentioned in that lesson while most people who buy and sell over the short term focus on technical analysis and most people who buy and sell over the long term focus on fundamental analysis, in my opinion both technical traders, fundamental traders, and investors can all benefit from at least having an understanding of both types of analysis even if they prefer one or the other as their primary tool they use to make their trading decisions.

While technical analysis focuses solely on the analysis of historical price action, fundamental analysis focuses on everything else including things such as the overall state of the economy, interest rates, production, earnings, and management. When analyzing a stock, currency or commodity using fundamental analysis there are two basic approaches one can use which are known as bottom up analysis and top down analysis. Bottom up analysis very simply means looking at the details such, as earnings if we are talking about a stock, first and then working one's way up to the larger picture by looking at things such as the industry of the company who's stock you are trading and then finally the overall economic picture. Top down analysis on the other hand means looking at the big picture things such as the economy first and then working one's way down to the details such as earnings if we are talking about a stock.

While there is some debate about which method is best my personal preference is for Top Down analysis and since by starting this way we can start with the things that apply to all markets and not just the stock market this is how we will start.

The first thing that it is important to understand from a fundamental standpoint is what the economic situation is as it affects the financial instrument you are trading. As I am based in the US and the US is the World's largest economy this is what I am going to talk about, however most of the things I discuss here apply in a broad sense to any economy. When we begin to discuss the foreign exchange market in later lessons we will go into specific details of the other major and emerging market economies from around the world.

According to Investopedia.com the definition of an Economy is "the large set of inter-related economic production and consumption activities which aid in determining how scarce resources are allocated. The economy encompasses everything relating to the production and consumption of goods and services in an area"

People often refer to the US Economy as a capitalist or free market economy. A capitalist or free market economy in its most basic sense is one in which the production and distribution of goods and services is done primarily by private (non government) companies and the price for those goods is set by the free market. This is in contrast to a socialist or planned economy where production and distribution of goods and services as well as the pricing of those goods and services is handled by the government.

While, as I state above, most people refer to the US Economy as a capitalist economy it is really more of a blended economy as the government does handle some things on behalf of the population such as the military, road building, and education.

So why is this important for a trader to know? Very simply moves towards capitalism and free market ideas are normally seen by the market as pro business and growth while moves towards more socialist ideas are normally seen by the market as anti business and growth. With this in mind whenever there is a move towards capitalism by an economy all else being equal you will normally see markets rally on this news and whenever there is a move away from capitalism you will normally see markets sell off on this news.

That’s our lesson for today. In tomorrow’s lesson we are going to take a deeper look into the different parts of the US Economy and what makes it tick so we hope to see you in that lesson.

As always if you have any questions or comments please feel free to leave them in the comments section below so we can all learn to trade together, and good luck with your trading!

External Links

Planned Economy

Market Economy

Definition of Economy